Feds secretly investigated WaMu slide for months

Originally published October 16, 2008 at 12:00 am

Updated October 16, 2008 at 11:24 am

For months, federal prosecutors in Seattle have kept the lid on an expanding criminal investigation into Washington Mutual Bank, fearing publicity of the probe would panic investors and depositors and cause a run on the teetering financial institution.

For months, federal prosecutors in Seattle have kept the lid on an expanding criminal investigation into Washington Mutual Bank, fearing publicity of the probe would panic investors and depositors and cause a run on the teetering financial institution.

With WaMu’s catastrophic collapse last month, a federal law-enforcement source familiar with the investigation said, the need for secrecy became moot. As a result, U.S. Attorney Jeffrey Sullivan went public Wednesday, revealing the existence of a WaMu task force.

“I want to assure our community that federal law enforcement is examining activities at the bank to determine if any federal laws were violated,” Sullivan said.

He urged anyone with information to contact the task force at 866-915-8299 or fbise@leo.gov. “For more than 100 years, Washington Mutual was a highly regarded financial institution headquartered in Seattle,” Sullivan said in a news release. “Given the significant losses to investors, employees and our community, it is fully appropriate that we scrutinize the activities of the bank, its leaders and others to determine if any federal laws were violated.”

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Even as Sullivan’s office sent out its statement, regulators from the Federal Deposit Insurance Corp.’s Office of Inspector General moved through WaMu’s downtown Seattle offices, taking documents and copying computer hard drives, workers said.

Sullivan declined to discuss the investigation further. His spokeswoman, Emily Langlie, said a team of prosecutors led by Assistant U.S. Attorney Carl Blackstone, who heads the office’s Complex Crimes Unit, was coordinating the investigation.

Task-force agencies include the FDIC, the FBI, the Securities and Exchange Commission and the Internal Revenue Service.

Largest bank failure

Washington Mutual became the largest bank failure in U.S. history on Sept. 25, when it was seized by the FDIC and its banking operations were sold to JPMorgan Chase of New York for $1.9 billion.

Before it failed, WaMu’s financial standing had crumbled so badly that credit-rating agencies gave its debt junk-bond status.

Like other lenders, WaMu was seduced by the fat profit margins available with subprime and other risky home loans. It waded into that market so deeply that by the time it tried to pull out, no one wanted to buy the loans and WaMu was stuck with them.

In addition to the criminal investigation, WaMu’s deterioration and ultimate collapse have generated dozens, if not hundreds, of lawsuits throughout the U.S.

In February, all of them were consolidated into a massive class-action lawsuit in Seattle before U.S. District Judge Marsha Pechman. Some of the lawyers involved believe it presents a road map for federal prosecutors.

Lynn Sarko, a former federal white-collar-crime prosecutor and now an attorney at the Seattle law firm Keller Rohrback, is representing WaMu employees whose retirements evaporated with the collapse. “We’ve known of this investigation,” Sarko said.

As with the lawsuits, it appears several smaller criminal probes in different parts of the country have been consolidated under the U.S. Attorney’s Office here, he said.

The investigations intensified as WaMu faltered. They have consolidated into what Sarko says “appears to be a very serious investigation” into “a merger of bad loan practices and possible fraud.”

“The question is going to be, ‘Did Washington Mutual hide what they knew about these loan portfolios?’ ” he said. “It isn’t whether WaMu was just buying these junk loans. They were the ones creating the junk.

“When do you go from negligence to recklessness to intentionally holding your nose while you do this?”

The class-action allegations fill a nearly 500-page complaint claiming that the company lacked risk management, inflated home appraisals to justify larger loans, and used “dangerously lax underwriting standards.”

The New York law firm overseeing the lawsuit said more than 90 current and former WaMu officials have provided the plaintiffs with documents and statements about fast-and-loose loan practices at WaMu.

“Tip of the iceberg”

The lawsuit alleges that when one “recently departed” high-level WaMu executive was told of the extent of the allegations in the lawsuit, he replied, “That’s only the tip of the iceberg.”

WaMu lost $16.7 billion in deposits between Sept. 15 and 24, prompting the FDIC to take over.

Representatives for JPMorgan and the FDIC declined to comment on the federal investigation.

The FBI is reportedly investigating four other U.S. financial institutions whose collapse helped trigger the $700 billion bailout plan by the Bush administration.

On Sept. 23, an Associated Press report cited two unnamed law-enforcement officials who said the FBI is looking at potential fraud by mortgage-finance giants Fannie Mae and Freddie Mac and insurer American International Group (AIG). A senior law-enforcement official said Lehman Brothers Holdings also is under investigation. The inquiries will focus on the financial institutions and the individuals who ran them, the senior law-enforcement official said.

FBI Director Robert Mueller said in September that about two dozen large financial firms were under investigation. He did not name any of the companies but said the FBI also was looking at whether any of them have misrepresented their assets.

Such probes are not new to Seattle. In the 1980s, a grand jury looked into the lending relationships of Seafirst, a local bank that got into trouble with loans to the energy industry before it was rescued by BankAmerica. The grand jury took no action.